Home Price Recovery Will Take Three Years, Morgan Stanley Says

There's more pain ahead for the housing markets, according to a recent report from Morgan Stanley.

How likely is this nightmare, and what can you do with this information?

"We see potential for another 5-10% decline in nominal prices over the next year," said the authors of "U.S. Housing Strategy: The Long Road Home," an analysis out this month from Morgan Stanley.

Even after home prices hit bottom, Morgan Stanley's experts think home prices will stay low "for another three to four years, during which annual appreciation may reach only as high as inflation or income growth."

Only a few economists still expect a big drop to home prices this year, though most expect prices to sag.
Morgan Stanley is on the pessimistic end of housing forecasts with its prediction of a potential drop of 5 to 10 percent. A decline like that would drag down the closely watched Case Shiller Home Price Index to between 136 and 129.

Other housing economists have softened their forecasts. In December, Mark Zandi, chief economist of Moody's Analytics, predicted that home prices had a long way to fall before hitting bottom this autumn -- down more than a third from its housing boom peak. His prediction back then, in an interview with Reuters, would have sunk the 20-city Case Shiller Index to about 128 -- more than 10 percent down from its current level.

Freddie Mac's May Housing Market Outlook, also relatively optimistic, predicts the Case Shiller Home Price Index will fall just 2.8 percent this year. After that prices will flatten out with an overall increase or decrease of zero in 2011. That would drag Case Shiller to about 142 by the end of the year.

With the index softening over the past few months, we're already halfway there.

The sunniest of 100 housing watchers surveyed by MacroMarkets predicted housing values would increase this year by 7 percent -- the average called for a very slight decline, so small it rounds to zero.

Why should prices fall at all? With the economy supposedly in recovery, why wouldn't home prices spike upward instead? Economists lay most of the blame on the aftereffects of the financial crisis -- including the high rate of mortgage defaults and the inventory of loans in foreclosure.

According to Morgan Stanley, the shadow inventory includes all the properties that eventually will need to be liquidated through foreclosures or short sales. They consider most of the 7.5 million properties whose borrowers are more than 30 days late in their payments as likely to be liquidated, eventually. Of those 7.5 million, over 5 million properties have loans that are more than 90 days late.

Several recent reports, including ones from TransUnion, Fitch Ratings, and the Mortgage Bankers Association of America, show that the number of loans with late payments might finally be leveling off, or even decreasing, after rising relentlessly for years. That might be the biggest reason some economists are slightly less pessimistic.

Still, no one is expecting good times to return anytime soon.

So if you are planning to buy a home, make sure to gather recent comps -- and then bid slightly lower.